Tesla cancels price leader, turns a profit, but can they sustain it?

Base-battery Model S spiked before a single one built.

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As the world got ready for the onslaught of corporate April Fools press releases, Tesla Motors quietly slipped out a press release on Sunday to announce
that it had, in fact, achieved a profitable quarter for the first time in its 10-year history and cancelled its lowest-cost model. These two items are
almost certainly not unrelated, and the cancellation is probably part of the effort to maintain profitability beyond the next quarter or two.

Back in 2010, when Tesla CEO Elon Musk put on a huge show to unveil the Model S at the headquarters of his other company, SpaceX, the two big headlines
were a claimed 300-mile range and a sub-$50,000 price tag. Unfortunately, it was not actually possible to get both of these features on the same car.

The price, less than half of what Tesla's only previous car, the Roadster, cost was a big deal. To achieve that target, Tesla lumped in the available
$7,500 federal tax credit and a smaller 40-kilowatt-hour battery pack that would only yield a nominal 160-mile driving range. While that range was still at
least 60% better than what most other automakers were claiming for their EVs, it was a far cry from 300 miles.

Despite positioning itself as a different kind of car company, Tesla did the same thing that most every automaker does by offering an ad-friendly
entry-level model at an attractive price that it didn't expect many customers to actually choose. For most automakers, these stripped base models usually
account for about five to 10 percent of sales, with most customers choosing to add options that only tack on a little manufacturing cost, but often
represent thousands of dollars in bottom-line profit for the manufacturer.

Similarly, as most companies usually pack early production with highly contented premium models, for the first several months after its release Tesla only
built the high-end 85-kWh Model S with the 300-mile range.

Now some nine months after kicking off production at the former Toyota/NUMMI factory in Fremont, California, Tesla is actually doing something different.
Before building a single 40-kWh Model S, it has opted to never build any. Instead, customers who placed orders for the base model (they only
accounted for around four percent of the orders) will get cars with the formerly mid-range 60-kWh lithium ion battery pack for the originally agreed-upon
price.

These cars will still be stuck with the nominal 160-mile range because Tesla engineers will limit the usable capacity of the battery in software by
limiting the maximum charge and discharge. This change will actually be beneficial to customers in several ways. The 40-kWh models were going to be limited
to lower maximum output and acceleration than the more expensive versions and weren't going to have access to the available and highly touted 480-volt
Supercharger network. Now the revised entry models will accelerate faster and be able to charge faster.

This change may also benefit battery durability in the long run. Tesla has always used virtually the full capacity of its batteries, which increases the
risk of damage from overcharging or deep discharges. By limiting usable capacity in the same way that other automakers do, the battery should hold up
better several years down the road.

For customers who later decide they actually want the extra capacity, Tesla will follow the current Silicon Valley trend of in-app purchases with a
software upgrade that unlocks the full 60-kWh. No pricing has been announced, but it's probably reasonable to assume it will be close to the $10,000 price
differential between the 40 and 60 kWh packs.

So why make this change now? It all comes back to the other news item, Tesla's first profitable quarter. Most automakers keep their price leaders around
despite selling few of them. However, most companies also have a range that consists of more than one model. Following the recent announcement that the
Model X crossover is delayed until late 2014, Tesla needs to make do with the Model S.

Following an excruciatingly slow production ramp-up last summer, Tesla was cranking out 500 or more cars a week by early 2013. No doubt, Tesla wanted to
get as many cars into customer hands as possible this quarter in order to book the revenue and achieve Musk's publicly stated target of turning a profit.

While this is the first time in its history that Tesla has turned a profit for a full three-month period, it's not actually the first time the company has
claimed a profit. Back in 2009, Tesla claimed the company made a profit for the month of July, something it has not repeated since. That profit was created
by a one-time confluence of delivering more than 100 Roadsters and shipping battery packs and other parts to Daimler for the Smart EV test fleet.

In subsequent months, Tesla returned to losses. Roadster deliveries gradually slowed as the pre-order backlog was depleted and few new sales came in to
keep the pipeline full.

Although Tesla has stopped reporting new orders and doesn't report monthly sales as other automakers do, it's estimated that the company had somewhere
around 10,000 pre-orders by the time the Model S was actually available. The Model S has been justifiably praised by most reviewers, us included, but it still has limitations.

Aside from the electric drive and the huge touch display in the center stack, it actually doesn't offer most of the amenities that customers in the
$60,000-100,000 price range expect from other manufactures. Besides the obvious lack of cupholders, customers can't get other popular features like lane
departure warning, blind spot indicators, adaptive cruise control and more.

Eliminating the lower-margin and slow selling 40-kWh Model S will allow Tesla to guarantee a higher minimum transaction price and simplify production by
eliminating some variability.

Once the initial surge of pent-up demand for the Model S has been fulfilled, will Tesla get enough new orders to keep the Fremont plant humming at or near
its 20,000 planned capacity until the Model X and other future vehicles arrive? It's probably safe to assume that Tesla will remain profitable for at least
the next quarter or two. The big question is what the numbers will look like in 2014.